The Six Principles for Long Term Investing
The stock market is filled with uncertainty and people questioning how long this economic expansion is going to continue. The reality is that even the world’s most successful investors cannot accurately predict where the market is heading. We must accept that certain things like economic and market conditions are out of our control. What we can control is how we approach investing. A tried and true formula is long-term investing which involves staying invested and continually investing no matter what the market is doing. More importantly, a successful long-term investor has a plan and sticks to it no matter what their gut is telling them. Here are the 6 principles for long term investing:
1. Plan on living a long time
We are living longer than ever before thanks to advances in medical technology and practices. As you can see in the chart below (left side) when a married couple reaches age 65 there is a 90% chance that a least one of them lives to 80 and a 48% chance that one of them lives to 90. This means that a retirement of 20+ years is more likely to happen than not. Which brings us to right side of the chart which illustrates the retirement savings gap. The grey bar shows that 64% of people believe they need more than $500,000 for retirement. The other three bars show the median account values based on age. So, the median retirement account for people age 65-74 is $126,000, which creates a gap of $374,000.
2. Cash isn’t always king
The left side of the cart below shows the income earned from $100,000 invested in a 6-month CD. Last year that investment would have generated $589 in income compared to $5,240 in 2006. While interest rates have risen on many cash accounts, the average rate on a traditional savings account is still well below the rate of inflation. With the expectation that the Fed will not be raising rates much more this year, investors should be sure an allocation to cash does not undermine their long-term investment objectives.
3. Risk assets vs inflation
This chart shows the relationship between asset classes and inflation over a long period of time. As you can see risk assets are the only ones that are consistently able to outpace inflation. With people living longer it is important to avoid becoming overly conservative during retirement as inflation can erode the purchasing power of your assets.
4. Avoid Emotional Biases by Sticking to a Plan
This is perhaps the most crucial of all the principles and the hardest. As humans it is nearly impossible to keep our emotions out of decision making, especially when it comes to our money. Making investment decisions based off emotion often leads to the biggest mistakes. These mistakes can be avoided by working with an advisor to develop and stick to an investment plan. The chart below shows the annualized returns of the average investor, the S&P 500, and other asset classes over the last 20 years. 2.6% for the average investor vs 7.2% for the S&P 500 is clear proof that individuals allow their emotional biases to affect their decisions.
5. Volatility is normal: Don’t let it derail you
As we saw in Q4 in 2018 volatility is a concern for everyone especially in the later stages of an economic cycle. However, volatility is more normal then most people realize. The red dots on this chart represent the maximum intra-year decline in every calendar year for the S&P 500, since 1980. While these pull-backs can’t be predicted, they can be expected; after all, markets suffered double-digit declines in 22 of the last 39 years. But despite the many pull-backs, roughly 75% of those years ended with positive returns, as reflected by the gray bars. Again, working with an advisor to stick to a plan can help you here.
6. Staying Invested Matters
Market timing can be a dangerous habit. Sometimes, investors think they can outsmart the market; other times, fear and greed push them to make emotional, rather than logical, decisions. To successfully time the market, you need to be right about when to pull your money out and when to put it back in. If you are wrong, it can cost you a lot. The first bar in the chart below is the annualized return of the S&P 500 form January 4th, 1999 to December 31, 2018. The second bar shows that return if you missed the 10 best days of that same period. Even worse, six of the best 10 days occurred within two weeks of the worst 10 days.
Being a long-term investor is not as easy as it sounds. It involves staying invested and sticking to a plan when everyone else around you may be panicking. It requires you to face the reality that certain things are out of your control. Working with an advisor can help alleviate some of these stresses. At Blue Bell Wealth Management, we would be happy to sit down with you and discuss a long-term investment strategy.